CreditCardCo Blog

When is written off credit card debt not really written off? That answer would be tax time. Many former homeowners are learning that their foreclosures could spell taxable trouble and that trouble is with the IRS if they fail to comply with documentation rules.

Now that tax season is upon us, many are also learning the same holds true for any credit card balances that were written off by their card carriers.

The Collection Agencies

During the tough economic times of recent years, many credit card companies brought in collection agencies in an effort to collect seriously delinquent credit balances. Often, those collection agencies would negotiate settlements on behalf of the banks or card companies.

The customer would agree to pay a fraction of what their balances were and the rest would be forgiven by the credit card company. The mindset was that something paid was better than nothing paid and for customers, it meant the end of annoying collection calls. Now, though, the difference between the settlement and the original balance must be claimed on tax forms as taxable income.

For example, if you owed $5,000 on your Visa and the collection agency or bank agreed to settle for $3,000 as payment in full, that $2,000 is what must be included in your tax returns. And if you’re thinking to yourself, “No one told me that”, it’s because the collection agency isn’t interested in doing you any favors. It’s working to collect debt for its client.

Growing Numbers

As mentioned, the same holds true for foreclosed homes, but it really applies to any forgiven debt. Student loans, second mortgages and signature loans are all bundled into this requirement.

Between 2003 and 2009, the IRS reports the number of forms filed with individual’s tax returns has more than doubled. In 2003, there were around one million of these forms and for 2010, the IRS is predicting close to three million. By 2012, predictions are those numbers could be closer to 3.5 million.

Clearly, the problem continues to grow, despite assurances the recession is now a part of the past. Interestingly, these numbers, while they reflect those associated with foreclosures, student loans and lines of credit, the lion’s share is attributed to credit card debt.

Now What?

So what happens if you agreed to the settlement early in 2010 and can’t remember the specifics? If the debt was more than $600, your credit card company will be sending an IRS form 1099-C, or a “Cancellation of Debt” form. This form will have all the details needed to ensure you’re in compliance. To be even more specific, this information will go under “other income” on your tax returns.

Here’s the real kicker, though. Because overwhelmed Americans have grown so accustomed to threatening letters and bills coming in the mail on a seemingly daily basis, when they see yet another piece of mail from a collection agency they’ve already dealt with, there’s a good chance it’ll be mistaken as another demanding letter that somehow got sent out after the account had been paid. And because of that, they may trash it without ever having opened it. This, coupled with the fact most folks have no idea they must claim this difference, brings the implications front and center.

What to Do

The best bet for anyone who’s settled with a creditor during 2010 is to check with that creditor if you’ve not received the 1099-C. Request it be sent immediately. Regardless of whether you simply haven’t received it or if you suspect it might have been trashed, you still need it to complete your tax returns.

Otherwise, you’re looking at penalties and fines that could realistically surpass the original balance you owed before you ever negotiated the lower settlement. This, of course defeats your purpose, especially if you’re still in recession recovery mode. One step forward and two steps back – never a good idea. Cover your bases now while there’s still time. April 15 has a way of sneaking up on even the best-prepared.